HOLDING TOO MUCH CASH IN YOUR BANK ACCOUNT?
It’s obviously a good thing to have lots of cash on hand. You can easily get your hands on the money when you need it, and at least it won’t go down in value.
But holding too much cash in your bank account can be a bad thing – especially in the longer term. We highlight this issue because we are regularly seeing new clients, who are holding more cash investments than we would generally recommend. They do it for understandable reasons – they are nervous or inexperienced when it comes to investments, or they have particular projects in mind.
- How much cash is too much?
- Why holding too much cash is losing you money
- Possible solutions
But how much cash is too much?
We believe that you should have enough cash put aside to cope with emergencies and short-term projects and the rest should then be put to better use (so long as you are not completely risk averse).
For most people, this generally means having 3-6 months of household expenditure put aside in an instant access account. This is not there to buy a new car, go on holiday or pay your income tax bill. It is there as an emergency fund. If you have any other short-term cash needs, or projects in mind, then put more money aside in separate accounts for each project.
This is only a rule of thumb, and you should apply some common sense to your own circumstances. For example, if you are self-employed you might want to consider holding more in cash – perhaps enough to last you a year.
If you have more cash than this put aside you are either completely risk averse, or you are effectively losing out on some serious future growth.
Why holding too much cash is losing you money
It doesn’t take a genius to work out that the returns on cash and bank accounts are pretty dire at the moment. If you’re lucky you might be getting 2% interest and this is taxable. To get this you need to shop around regularly to avoid the bank putting you on some measly rate after the introductory rate is over.
But the real killer to your future prosperity is inflation, which is currently running at a higher rate than that paid on bank accounts.
Here are some recent figures prepared by Blackrock:
If you had £100,000 in cash, after 10 years it would have lost around 20% of its purchasing power; after 25 years this money would be worth less than half the original purchasing power – £47,761 .
These figures assume inflation at 3% per year and that you do not reinvest the interest.
What is the solution?
Find your level of the correct cash holdings and make sure you are not holding too much cash in your bank account. Then you can apply sensible investment principles to the remaining assets over this balance. Over time, this should generate you much greater rewards than simply holding cash. Of course, no investment is without risk, but if you are prepared to take some risk, you should beat inflation.
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